Commodities & Energy Sector

The remarkable admission by OPEC's secretary-general, Salem el-Badri, earlier this week that with "any increase in (oil's) price, shale will come immediately and cover any reduction" in output only hints at the larger impact of light-tight-oil (LTO) going forward.

Where is the most likely mispricing of interest rates today? Plus our latest thoughts on the U.K.'s June 23 referendum on EU membership, and its market implications.

This month's Special Report reviews the main factors driving the "lower for longer" bond yield view. A key finding is that the demographically-driven portion of the expansion in world capital spending has come to a virtual standstill, representing a major hit to underlying demand growth.

The sheer scale of underperformance leaves the oilfield services group vulnerable to violent bounces, especially in view of the recent stabilization in oil prices as well as an agreement between several OPEC members and Russia to freeze output at current levels. Is it time to buy? While oil supply will eventually be reined in, demand growth is still up for debate. The global economy is struggling to maintain a decent rate of growth. Importantly, energy service stocks have an abysmal track record during recessions and/or when the ISM manufacturing index is below the boom/bust line. In other words, the group is a late-cycle performer, not an end-of-cycle performer. While the U.S. is not technically in recession, the odds of one are rising steadily as credit conditions tighten. Even then, upside potential may be more muted than in previous cycles. Fracking technology and producer's flexibility to quickly ramp up output suggests that the large boom/bust cycles in supply will not hold true going forward. The natural gas market is a prime example. The implication for oilfield services investors is that peak earnings could be much lower than in the past, which will reduce investor willingness to speculate on upcycles and warrant a higher risk premium. We are sticking with a neutral weighting, despite the likelihood of periodic oversold spikes. The ticker symbols for the stocks in this index are: SLB, HAL, BHI, CAM, NOV, FTI, HP, RIG, ESV, DO. bca.uses_in_2016_02_23_001_c1 bca.uses_in_2016_02_23_001_c1

The deeply negative momentum in oil prices is fading, setting up the possibility of a counter-trend rebound in global inflation expectations and perhaps even the beaten-up U.S. High-Yield bond market.

Lean against rally attempts until leading profit indicators improve. The conditions for a tradable oilfield services rebound remain elusive. Capital markets may bounce, but we would sell on strength.

The agreement to freeze oil production should reduce tail risks, even if it does not improve overall corporate sector health and profits.

Markets see long-term global growth prospects as having deteriorated materially, with policymakers unwilling or unable to do much about it. Meanwhile, recent economic data - U.S. notably - hasn't been that bad. A divergence between what matters to Wall Street versus Main Street explains the disconnect. Accelerating wage growth, lower commodity prices, and cheaper rates are positives for households - but not for many Wall Street sectors. Stay neutral global equities. T-bonds are a "hold" for now. The dollar's selloff is overdone.

While the oil market looked right through the Russian-Saudi production-freeze announcement earlier this week, we believe these states may be attempting to put lipstick on the proverbial pig, to provide a plausible narrative to explain the physical reality of lower oil production in a sub-$30/bbl world.